QuinStreet, Inc (NASDAQ:QNST)
F2Q 2014 Earnings Conference Call
February 04, 2014 05:00 PM ET
Erica Abrams – IR
Doug Valenti – Chairman, CEO
Greg Wong – SVP, CFO
John Campbell – Stephens Inc.
Good day, ladies and gentlemen and welcome to the QuinStreet Second Quarter Fiscal of 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time.
If anyone should require Operator assistance, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded.
I will now like to introduce you to the host of today’s Conference, Miss Erica Abrams of Leisure Group, you may begin.
Thank you, and good afternoon ladies and gentlemen. Thank you for joining us today as we report QuinStreet's second quarter fiscal 2014 financial results. Joining me on the call today are Doug Valenti, CEO; and Greg Wong, CFO of QuinStreet. This call is being simultaneously webcast on the Investor List Relations section of our website at www.quinstreet.com.
Before we get started, I would like to remind you that the following discussion contains forward-looking statements. These are statements that relate to future events or financial performance and involve risks and uncertainties. QuinStreet's actual results may vary materially from those discussed here.
Factors that may cause the results to differ from our forward-looking statements are discussed in our most recent 10-K filing with the SEC, completed on August 20th 2013. Forward-looking statements are based on current expectations, and the company does not intend to and undertake no duty to update this information to reflect future events or circumstances. Now I will turn the call over to Doug Valenti, CEO of QuinStreet. Please go ahead.
Thank you, Erica . Hello, everyone and thank you for joining us today. Revenue in the quarter was $66 million, just below outlook range we provided due primarily to unexpected changes in client budgets at year end. Adjusted EBITDA was 10% of revenue, consistent with our outlook. Importantly, that EBITDA margin reflects aggressive investment in a wide range of initiatives to navigate current market challenges and to diversify our products, median markets in ways that we are confident will drive future growth.
Our balance sheet and cash flow remains strong as they have throughout this period of transition providing a solid, safe foundation for our operating efforts. We are making more progress faster on more important initiatives than at any time in company history.
That progress is not yet driving top line growth. Because of the large scale and persistence of the market challenges we are facing and are working to offset – and, due to the naturally earlier stage in smaller scale of the growth initiatives. But, our efforts have significantly dampened the effects of the challenges. Our overall business mix has shifted approximately 30% over the past year.
With areas of growth largely offsetting the clients in lead demand, from for-profit schools still a vacuum to new regulations and drops in auto insurance clicks caused by market changes and competitive challenges.
We are more confident than ever that our initiatives – which are just in big market opportunities – will eventually more than offset the head winds and lead us back to growth. Here are updates on the progress of some of our growth initiatives in the quarter.
Auto insurance policy revenue – an important component of our strategy to diversify our auto insurance products – grew 69% year-over-year. Revenue for calls and clicks in education both key new products in Davenport and client vertical, grew 356% and 43% respectively year-over-year.
Our education revenue in Brazil, the focus of our near term international expansion efforts, grew 123% year-over-year. Revenue in education for not-for-profit per secondary schools, grew 67% year-over-year. We are focused on serving not-for-profit schools particularly, their online programs as that fast growing market ramps – not-for-profit colleges represent some 85% of the overall post-secondary market. Though, they have historically had a small footprint in online programs and low marketing spend relative to the for-profits.
That is changing. Online searches for not-for-profit school brands recently surpassed those who are for-profit colleges for the first time in memory.
As they push to ramp their online programs and marketing efforts – not-for-profit schools represent a huge distillery market that represents an enormous growth opportunity as it continues to develop.
Also in education, we continue to gain share among for-profit schools where we have been historically under-penetrated. Even as the overall for-profit market remains challenging and at best volatile. Revenues among that targeted under-penetrated group of for-profit clients grew 52% year-over-year.
Finally, and very importantly, our revenue from mobile traffic grew 56% in the quarter year-over-year. Mobile traffic continues to grow rapidly online and consequently in the mix for our programs. We continue to focus aggressively on better engaging and serving visitors on mobile devices. Our revenue per visitor for mobile traffic is now essentially on par with desktop. And hugely important milestone and driver of continued progress.
The above initiatives alone delivered over $20 million in total revenue last quarter. We are compounding rapid growth in these areas on a still early but increasingly material base and against big market opportunities.
Now, I’d like to talk in more detail about our efforts and progress in auto insurance. The largest of our vertical market opportunities and the main focus of our diversification and development efforts and investments over the past three years.
During that time, auto insurance marketing online has undergone dramatic structural changes and increased competition. While online marketing approaches in products in the important third party segment, which includes us, has been stagnant.
Our investments in new products are key to breaking us out of that jam and to drive in new growth for us and the channel. The new product development and launch effort – launch efforts – have been long, difficult and expensive – frustratingly so, especially with respect to pace and timing.
But, the progress has also been sure. And we believe it will have been well worth the effort and the wait.
In addition in big investments in product development, I have had to make big changes to our organization, including significant flattening and even running auto insurance directly for an extended period in the past year – in order to effect complicated but necessary innovations at a faster pace.
Now, finally, as of this quarter, our full range of complementary new products in auto insurance will all be launched including recoded, more flexible and usable policy flows, new competitive lead products, expanded call and call center capabilities and an important new version of our historically core click product.
We have client commitments for all of these products. And I have personally visited many of our biggest auto insurance clients over the past month to confirm their enthusiasm, strong interest and demand.
With these pieces in place, we are now able to push forward efforts to ramp our auto insurance business at scale in earnest.
I do not expect to see much of an inflection and impact from the top line for those efforts in the current quarter. But I do expect to begin to see it in fiscal Q4 and beyond and what we expect to be an accelerating pace.
Turning to our outlook for the current quarter. We expect to be up seizely and sequentially this quarter. But, the dynamics of the business will be very similar to what we have seen in the past few quarters. Navigating challenges was good progress on a range of important, but still early, initiatives as described and outline above.
We expect revenue in the range of $68 to $72 million and adjusted EBITDA margin of approximately 10% as we will continue to invest aggressively in growth initiatives, particularly in auto insurance.
With that, I’ll turn the call over the Greg for a more detailed discussion of our financial results.
Thanks, Doug. Hello and thanks again for joining us today. For our second quarter of fiscal 2014, we posted $66.1 million of revenue, a 8% decline compared to the same quarter last year. Adjusted net income for fiscal Q2 was $3 million or $0.07 per share on a fully diluted basis.
Adjusted EBITDA was $6.5 million or a 10% margin. Our Q2 performance was slightly below what we expected to see on the top line largely due to unexpected changes in client budgets as they approach their fiscal year end. That being said, our fundamental circumstance remains the same. We believe we are continuing down the right path for our return to growth. We continued to make good progress with our primary growth initiatives. Those being our product, market and media expansion strategies while the same time maintaining a solid balance sheet, adjusted EBITDA margin and cash flow.
Seen that overall context, I’ll now discuss the details of our fiscal Q2 results. Please see the supplemental data sheets available for download on the Investor Relations page of our corporate website. They provide essentially all of the figures that I will now walk you through.
For revenue by client vertical, our education client vertical represented 45% of Q2 revenue or $29.8 million. The year-over-year decline of 9% was driven by the continued challenges in the for-profit education market. This clients in the vertical are still reacting to the regulatory changes.
To offset the for-profit industry head winds, we’re making good progress with our initiatives to diversify our product, markets and media. And we are confident that we will be in even stronger competitive position once the for-profit challenges subside.
To provide some color around the strategic initiatives, our product expansion strategy is progressing well. We continue to see nice year-over-year growth with both our relatively new click and call products. These products we believe reduce risk and provide high quality inquiries to our clients.
While we work hard to diversify our product set, we have a continued focus on optimizing the quality and monetization of our traditional lead business.
We are also making good progress around our market expansion strategy. We are seeing impressive growth in revenue and our presence with not-for-profit schools, a growing segment of the market is they are standing to include online offerings themselves.
As you know, not-for-profits represent the vast majority of post-secondary educational institutions. And, although this is an early market for performance marketing online, it represents a huge market opportunity for QuinStreet over the longer term.
Our expansion in the international markets particularly Brazil, continues to go well. Nursing solid revenue growth and know that the numbers are still relatively small, it remains a big, strategic long term growth initiative for us.
As a reminder, our education client vertical is a solid profitable client vertical for QuinStreet. We believe we are the leader in this space in terms of revenue, market expertise and competitive assets. This is a great long term business for us, if challenged in the near term.
F&H’s services client vertical represent a 37% of Q2 revenue or $24.3 million. The year-over-year decline of 8% was primarily due to unexpected changes in client budgets as they approach their fiscal year end and also continued challenges accessing a sufficient amount of high quality media and acceptable margins due to changes in search engine algorithms, acquisition of media sources by competitors and increased competition in auto insurance.
This continues to be a highly competitive market for online media in auto insurance. And our path forward remains the launch and sale of our broader product offerings where the increased [INDISCERNIBLE] from those products will allow us greater media reach.
To provide some context to this client vertical, auto insurance is the largest market in our overall financial services client vertical. Client marketing budgets in auto insurance are substantial. And this is an early market for performance marketing online. A primary growth initiative in auto insurance is the expansion of our products in which we still offer clicks with the addition of leads, calls and down policies.
As Doug mentioned, our full range complementary products will launch this quarter which we believe will enable us to scale out our auto insurance business and we expect those efforts to drive a meaningful impact in the fourth quarter and beyond.
Revenue from our client verticals which include B2B technology, pump services and medical, represented 18% of Q2 revenue or $12 million. Over time, we like these verticals and the market opportunity they represent. Moving to the discussion of EBITDA, for adjusted EBITDA, we delivered $6.5 million dollars or a 10% margin. Consistent with the outlook we provided last quarter.
We’re continuing to aggressively spend on initiatives that we believe will drive meaningful and sustainable growth over time.
Moving to the tax front, our provision this quarter included a one-time charge of $40.2 million to establish a valuation allowance against our deferred tax assets. Resulting primarily from last year’s goodwill impairment. Establishing the valuation allowance was required by GAAP, but to be clear, our deferred tax assets has expiration dates many years out and we expect to be able to utilize them in the future to offset tax liabilities.
To provide some further context, this is a non-cash item and is excluded from non-GAAP results. For your modeling purposes, we expect our ongoing rate to approximately 40%.
Moving to the balance sheet, our cash and marketable securities balance at quarter end was $122 million. You can see the details in the cash flow statement from our range release. But, the largest items were the generation of $6.5 million of cash flow from operations. Capital and tangible expenditures of $6.1 million and payment on debt of $4.2 million.
The vast majority of our capital and intangible expenditures in the quarter were either one time or infrequent in nature. These related to a final payment for licensing and patents. Our data center technology infrastructure refresh and expansion of our internal call centers to support our strategic growth initiatives.
Total debt decreased to $85 million from $90 million in the previous quarter due to repayments, we had no new borrowings.
Our net cash position is a positive $37 million. Normal as with cash flow, for the first half of the year, was $8.7 million or 6% of revenue.
To summarize, we are facing known challenges in our core verticals and those challenges continue to negatively impact our financial results. That being said, we’re in a period where there’s more innovation and progress within the company than at any time in our history.
We are now more confident than ever that the progress we’re making with our strategic initiatives will eventually overcome industry head winds and lead us to a return to growth.
While we continue to work hard to deliver better results, our balance sheet remains strong as we continue to generate solid adjusted EBITDA margin and cash flow.
We look forward to updating you with our progress on our next earnings call.
With that, I’ll turn the call over to the Operator to open up Q&A.
(Operator instructions). Our first question comes from the line of Douglas Anmuth of JPMorgan. Your line is now open.
Hi, thanks this – thanks this is Diana Cliron for Doug. I just want to get a little bit more color on the next quarter guidance, if you guys could provide someone where specifically within the verticals – can you break up some of that. And then, just on the newer products, saying for queue will be the first quarter you see some incremental. How – how do you expect that to ramp whether it’s throughout that quarter. Any more color there would be great. Thank you.
Sure, Diana. In terms of the guidance, we really don’t break it out by vertical when we provide it. But, I think it will be largely more of the same. I don’t expect that the mix this quarter will change meaningfully from the mix that we saw last quarter. And so, if – it’s going to look a lot like the same mix, going forward. So that – as far – I guess adds up to the breakdown of the guidance.
In terms of how we expect it to ramp – we expect to have some results from the new products this quarter. I just don’t think that will meaningfully affect the top line. As we’re going to be very early but we’ll be starting in earnest this quarter.
My guess in the fourth – our best guess in the fourth quarter is that it could certainly be anywhere from hundreds of thousands of dollars a month in incremental revenue on top of where we’ve been with the kind of core click and early policy product – to millions of dollars a month. And I think, it kind of depends on how the ramps go. We feel very good and very strongly about those ramps. And we certainly see the opportunity on these paths – on the new products in auto insurance to get to many millions of dollars in more revenue over future – over coming periods. The question of it, what rate, we can expect the rate to be meaningful in the fourth quarter. And began to be able to see that rate, to be able to see it going down that paths right.
Unfortunately, I don’t think we’re ready – we’re only giving guidance one quarter on – we’re just not ready to say about how much. Obviously when we have the call, in what I guess would be April or early May, we’ll at that point give you a lot clearer view of that. And we’re excited and anxious to do for you.
Great, so you’ll be starting to sign contracts in this current quarter?
Oh, we have a lot – we already have signed contracts for most of products – for all of the products actually in this current quarter. We will be actually – we’ll be spending aggressively in the beginning of the ramps on all the products this quarter and expect revenue for all – for each and every one of those products this quarter.
Okay. Great, thank you.
Thank you, Diana.
And our next question comes from the line of John Campbell of Stephens Inc. Your line is now open.
John Campbell – Stephens Inc.
Thanks guys, good afternoon.
John Campbell – Stephens Inc.
Can you guys just talk a little bit about the pressure you guys mentioned about the client budget. Because maybe just break that up by vertical?
In the – in last quarter?
John Campbell – Stephens Inc.
Yes, it was primarily, the unintended – the difference between where we came in and where we had guided was – was pretty much all budget. Budgets that were stopped unexpectedly by financial services clients. That was the – you know – that was all of the difference, quite frankly, and it was client said, cut spend – they told us across the board.
One very large client and big spender with us – just frankly ran out of budget. They’d over – or I guess – overestimated what they could spend in the quarter and for the year. And they ran out of budget and stopped spending in November, on what had been a pretty darn high run rate. It would have put us pretty close to the middle of the range had they not done that. So, it was that – that’s the difference, the primary difference. There are, obviously other things happened, across – the rest of the business. But, that’s just kind of what happens in any given quarter.
But, if you’re – if we’re talking about the difference. The thing that drove the difference between where we were – where we came out in the range versus where we thought we would be – it was financial services and budgets there, particularly in auto insurance where those clients would spend.
John Campbell – Stephens Inc.
Great, thanks for that color. And then just – just from the conversations you’ve had with some of those clients – what is the budget looking like for – for 2014 for some of these guys.
Big. Big indications of budget availability and big indications of willingness to spend with us. Particularly as we get the new products live. Which they are – they’re essentially all live right now – but a couple of them are in the primary stages of QA and Beta. And again, by the end of this quarter, they will all be fully live and out of Beta and we have many clients signed up for every one of those. And, that’s a – so, the indications of budget are very strong. It’s going to be a question of , at this point, would these products, it’s a question of the – what rate we can ramp the effectiveness of those products and access and leverage those products monetization in the media.
And that will assuredly come, it’s just a question of it – what rate, what pace and that is not always a direct straight line there. But it’s a pretty quick line. But I would say, indications are they want to spend a lot more money in the channel and they would – and given the products – that – and I would again – I’ve got these direct conversations with three of our largest clients. Given where the products are and where they’re coming out – they’re indicating that if we can get the media, they want to spend that money with us.
John Campbell – Stephens Inc.
OK, great. And then, just trying, if I can just get one more here. You know, given the odds, are starting, I guess, to see the light at the end of that long investment cycle tunnel.
John Campbell – Stephens Inc.
What are your plans, going forward for, you know, future use of the cash and it looks like, you know debt reduction has been, I guess, somewhat top of mind for you guys. It’s been a pretty steady decrease. You know, quarter-over-quarter and then, maybe, if you can just give us your targeted debt ratio?
Sure, I’d say, you know, we have – because of the challenges in operations, we’ve been – we’ve taken a pretty conservative profile as I think you would expect us to do with the strength of the balance sheet. And so, our – what we’ve been doing is accumulating cash, paying down debt as necessary as it’s prudent given it’s a pretty low rate, we’re not super aggressive about doing that. But we have a schedule that we’re going to pay it down on. And we’ll – and that’s allowed us to generate a good margin of net cash which, again, given the operating challenges we’ve had – despite the fact that we have not gone cash flow negatively – we don’t expect to.
It’s allowed us to – to just be conservative. I would say that as we come out of this investment cycle and as we are able to ramp up auto insurance which we expect to do which will allow us to ramp margin back – to where we would like to be. And cash flow margins back to where we – where we would like to be and are closer to where we historically been. And just as an aside, you know, the margin degradation as we’ve indicated for quarters now is all about the investment in auto insurance.
Both on the expense side, as well as the top line leverage side, as well as the margin side – you put those three things together – we get back any normal scaling of auto insurance at any normal range of media and contribution margins. And we are well – well at our historically the down margins, the cash flow margins.
Now, I would say that we haven’t really crossed that bridge in terms of what we’ll do with cash in the long run. What we’ll do with cash is if we can’t deploy it against opportunities of whatever nature that allow us to get a good strong invest return for the shareholders, we’ll find other ways to deploy, to do so. And certainly, there are lots of things on the table. That had been discussed and that we’d like to engage in that way, that way is to get the tax back to shareholders.
It’s just not something that’s on our mind right now. What’s on our mind right now is make sure we keep really conservative financial profile and invest like crazy and this as you’ve heard, we see tremendous potential and opportunity and actually results from in that – in exchange in scale – but, we think shareholders would be best rewarded and paid for us returning to growth. And that’s really what we’re all about.
John Campbell – Stephens Inc.
Great, thanks for taking our questions Doug.
Yes. Thank you, John.
Thank you, again, ladies and gentlemen, if you have a question at this time, please press star and then the one key on your touchtone telephone.
Again, ladies and gentlemen, if you have a question at this time, please press star and then the one key on your touchtone telephone.
And I am showing no further questions at this time. That will conclude our time for question.
Ladies and gentlemen, this conference will be available for replay after 8 p.m. Eastern time today through February 10th 2014 at 11:59 Eastern time.
You may access remotely, replay system at any time by dialing 800 585 8367 or 855 859 2056 and entering access code, 332 42 918. International participants may dial 404 537 3406. Those numbers are again, 800 858 8367 or 855 859 2056 and international participants may dial 404 537 3406 with access code of 33 24 29 18. That does conclude our conference today.
Thank you for your participation in today’s conference. You may all disconnect, have a great day everyone.
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